The Wrap: PRRT, Fed, Health & Infrastructure

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This story features MEDIBANK PRIVATE LIMITED, and other companies.
For more info SHARE ANALYSIS: MPL
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

Weekly Broker Wrap: Petroleum Resource Rent Tax; US Fed rate hike; health insurer valuations; gaming sector outlook; major Australian infrastructure projects.

-Risk that PRRT review is used as a means to raise revenue
-Macquarie: health insurer investment case not supported at current levels
-Gaming sector to benefit from several initiatives
-Bottom line impact of major infrastructure projects muted for LLC and CIM
 

By Eva Brocklehurst

Petroleum Resource Rent Tax

The federal government is undertaking a review into the design and operation of the petroleum resource rent tax (PRRT). Citi observes, if the government is true to the stated efficiency focus of the Henry review, then changes should be small. The broker believes the regime is mostly performing as it was designed, that is to tax excess profits while not providing a disincentive to marginal projects.

The risk is that the review will be used as a means to raise revenue, which could then result in a substantial impact on valuations and future investment decisions. The broker believes the government, in seeking to increase its share of economic rent, should also consider that marginal LNG projects are becoming less competitive globally and face deferrals, while delays to planned mergers and IPO activity are being encountered amidst policy uncertainty.

The government also needs to note the higher gas and electricity prices on the east coast, given an increasing cost of supply. There is also a heightened perception of sovereign risk translating into reduced investment appetite from offshore, if only on a short-term basis. Citi concedes that predicting policy outcomes from a marginal government is difficult. The broker does note that Oil Search ((OSH)), with no Australian operations, is the only oil stock under coverage which is not exposed to PRRT risk.

US Fed Rate Hikes

Following the signals from Federal Reserve speakers over the last week, National Australia Bank analysts now expect an increase in the Fed Funds rate at this month's meeting. The analysts now expect three rate hikes in 2017 rather than just two.

This expectation comes despite some recent weakness in the data which will be used to estimate first-quarter GDP in the US. The analysts observe that weakness in the first quarter has not been unusual in recent years and surveys still show a solid underlying economy.

Members of the Fed have also indicated risks to the outlook have become more balanced, as overseas risks recede amid expectations of stimulative US fiscal policy. The main risk to a rate hike in March is the US non-farm payrolls report but this would have to be very weak to change the Fed's view, in the analysts' opinion. The Fed is not expected to be put off by a soft report particularly as other indicators of the labour market are running strongly.

Health Insurers

The investment case for health insurers is not supported at current levels, in Macquarie's opinion, given the combination of moderating premium growth that reflects structural pressure on policy-holder mix in the community-rated private health insurance sector.

Both Medibank Private ((MPL)) and nib Holdings ((NHF)) are operating at, or near, peak margins and claims growth has been below long-term trends. Macquarie downgrades both stocks to Neutral from Outperform as both stocks have closed the gap to the broker's valuation.

Claims growth remains materially below long-term trends and this is supporting profitability at present. A continuation provides a modest risk to the broker's view in the next 6-12 months. Another risk is a structural change to address the policy-holder mix and lack of growth among young members. The broker envisages very low risk of a change occurring in the next 12 months.

Gaming Sector

Despite the subdued macro environment, Deutsche Bank is positive about the gambling sector, given the initiatives companies have undertaken to enhance earnings growth. Star Entertainment ((SGR)) will benefit from the expansion of the main gaming floor in Sydney and the re-launch of its loyalty program. Crown Resorts ((CWN)) will benefit from cost reduction initiatives.

The broker's preference in the sector is Aristocrat Leisure ((ALL)), Star Entertainment and Crown. Aristocrat is trading at a 21% discount to the broker's valuation and its Buy rating is based on strong forecasts for a growth in earnings per share, an increase in recurring revenue and continued market share gains. Deutsche Bank suggests the share prices of both Tabcorp ((TAH)) and Tatts Group ((TTS)) will be determined by progress on the proposed merger between the two.

Infrastructure Construction

The value of major Australian transport projects under construction has risen to $33.9bn over the past two years and there are a further $85.5bn in projects slated to commence by 2020, Credit Suisse observes. Allowing for expected win rates, and an increasing requirement for joint ventures because of project scale, revenues from major transport projects are expected to grow by 11-15% from 2016-20 for both CIMIC ((CIM)) and Lend Lease ((LLC)).

Nevertheless, with such projects accounting for less than 10% of each company's earnings in 2016, on Credit Suisse's estimates, the impact to the bottom line is less significant than the huge value of these projects suggests. Larger projects do favour these two companies, by removing some less well-capitalised competitors from contention. Yet the increased size and complexity also tends to need joint ventures with other local or international groups.

The broker estimates that the two companies' combined share of transport project revenues has declined over the period since 2012, to 39% from 52%. This share has been picked up by international groups, primarily via joint ventures with these two. Improving transport infrastructure is just one of the several positive drivers envisaged for Lend Lease.

In the case of CIMIC, Credit Suisse believes current margins on projects are unsustainable and the recovery in mining and resource-related construction is likely to be gradual. Hence, earnings sourced from major road and rail projects need to be far larger in order for CIMIC's current pricing to be justified. The broker has a Underperform rating for CIMIC and Outperform for Lend Lease.

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